When a homeowner defaults on a mortgage payment, the lender has the right to begin foreclosure proceedings which ultimately lead to the lender taking legal title to the home. During the time a foreclosure works its way through a state’s system, the property may be put up for short sale, in which the lender agrees to a sale at a price below the mortgage balance. The rules on buying a foreclosed house depend on the type of foreclosure system adopted by the state.

Short Sales

Until the foreclosure is deemed complete under state rules, lenders may allow a short sale to preempt the foreclosure. The US Department of Housing and Urban Development administers the Home Affordable Foreclosure Alternatives Program that makes cash payments to lenders to induce them to favor short sales over foreclosures. If a buyer can strike an agreement with the seller and the lender before a foreclosure is completed, the sale can proceed. In some cases, the homeowner can tactically delay a foreclosure by declaring bankruptcy, for instance.

Nonjudicial Foreclosure

Many states, including California, have adopted nonjudicial procedures that keep foreclosures out of court. In many states, the process requires that the lender deliver a notice of default (NOD) and provide the lender an opportunity to pay off the debt. Until the NOD expires, a buyer can strike a deal with the homeowner to pay off the debt and buy the home. Failure to remedy the default by NOD expiration usually results in the issuance of a notice of sale, followed by an auction. State rules vary as to the lender reaching a pre-auction deal with a buyer once the notice of sale has been posted.

Judicial Foreclosure

In states with judicial foreclosure rules, a state court oversees the proceedings. The lender sues the defaulting borrower to win a final judgment, followed by an auction. Most states require an auction so that the borrower can extract any equity in the property that exceeds the mortgage balance plus court costs. In those states, no post-judgment deal between a buyer and lender is possible before the auction. Judicial foreclosure auctions are usually administered by a sheriff and the highest bidder gets title to the property.

Real Estate Owned Property

At most auctions, the lender can set the opening bid. If no bid comes in higher, the lender repossesses the property. Such properties are called real estate owned, or REO. If a buyer missed the opportunity to purchase a foreclosed house before the auction, an REO is a second chance to strike a deal. Since the property didn’t attract auction bids, a bank might be more flexible in accepting an offer for an REO property. Otherwise, the property is put up for sale through normal realty venues.

About the Author

Based in Chicago, Eric Bank has been writing business-related articles since 1985, and science articles since 2010. His articles have appeared in "PC Magazine" and on numerous websites. He holds a B.S. in biology and an M.B.A. from New York University. He also holds an M.S. in finance from DePaul University.